Working Paper: CEPR ID: DP8039
Authors: Yongsung Chang; Sunbin Kim; Frank Schorfheide
Abstract: This paper assesses biases in policy predictions due to the lack of invariance of ``structural'' parameters in representative-agent models. We simulate data under various fiscal policy regimes from a heterogeneous-agents economy with incomplete asset markets and indivisible labor supply. Imperfect aggregation manifests itself through preference shocks in the estimated representative-agent model. Preference and technology parameter estimates are not invariant with respect to policy changes. As a result, the bias in the representative-agent model's policy predictions is large compared to the length of predictive intervalsthat reflect parameter uncertainty.
Keywords: aggregation; fiscal policy; heterogeneous agents economy; Lucas critique; representative agent model
JEL Codes: C11; C32; E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal policy changes (E62) | shifts in preference estimates (D11) |
| Fiscal policy (E62) | average labor supply elasticity (J20) |
| Fiscal policy (E62) | labor market participation (J29) |
| Labor market participation (J29) | cross-sectional distribution of productivities (D39) |
| Lack of policy invariance (C54) | inaccurate predictions from representative-agent model (E17) |
| Measured preference shocks (D11) | fluctuations in hours worked (J22) |
| Biases in policy predictions (D79) | predictive intervals reflecting parameter uncertainty (C53) |